Asset Bubble and Banking Balance Sheet

Abstract

The burst of asset bubbles can have detrimental effects on the financial intermediary sector, transmitting shocks to the real economy and potentially triggering a crisis. In light of this observation, this paper investigates the interaction between two primary types of financial accelerators: asset bubbles and agency frictions within the banking sector, by incorporating both into a standard Dynamic New Keynesian model. Our findings indicate that financial frictions in the banking sector significantly influence the existence and magnitude of asset bubbles. Moreover, frictions within the banking sector exert a more pronounced financial acceleration effect compared to asset bubbles alone. The interplay between these two types of financial accelerators may lead to mutual reinforcement, with the reinforcing effect of banking sector frictions on asset bubbles being particularly substantial. Both bubble taxation policies and central bank guarantees for borrowing can help stabilize the economy by mitigating financial frictions. The central bank guarantee policy, which primarily focuses on stabilizing the balance sheets of financial intermediaries, demonstrates a more effective stabilization impact.

Keywords: Asset Bubbles, Banking Balance Sheet, Taxation Policy, Guarantee Policy

JEL Classification: E44, E32, G12, G21, G01